The problem with FOMO tempting investors into tech stocks

Following the COVID-19 meltdown on the Australian stock market, a new generation of investors who were stuck at home hit the market attempting to create some cashflow.

Primarily, their focus has been on technology stocks, so much so, that over the past few months talk around these stocks has accelerated at lightning speed. In order to understand the hype around these stocks, we need to take a closer look at the technology sector in Australia and the US.

In Australia, the sector is quite small in relation to our overall market - there is not one technology company listed in the top 50 on the All Ordinaries Index. While in the US, technology stocks make up a significant share of the S&P 500 given that the top six technology companies make up around 17% of the total market capitalisation of the Index.

To understand why Australians are so excited about technology stocks, however, we need to look at the NASDAQ, which is heavily weighted to technology companies. Since 1971, the NASDAQ has grown at a rate 0.65 points per day to the end of August in comparison to Dow Jones, which over the same period grew two times faster at a rate of 1.61 points per day. That said, in the 1970s technology was just getting started, so we need to look at more recent times to really gauge what is occurring.

Prior to the global financial crisis (GFC), the NASDAQ rose from October 2002 to the GFC high in November 2007 at a rate of 0.97 points per day. In the first 12 months following the GFC crash, it rose from March 2009 to April 2010 at a rate of 3.06 points per day.

Now let's compare that to what occurred recently in the run up to the COVID-19 crash. Between December 2018 and February 2020, the NASDAQ has been rising at 8.69 points per day, while over the past five months, from the low in March 2020 to the end of August, it has been rising at 33.09 points per day or 281% faster. Why has this occurred?

The faster a stock or market is moving, the more interest it generates from investors who jump in attempting to cash in for fear of missing out. The concern with this is that Australian investors are assuming that technology stocks in Australia will perform like their US counterparts. However, this is not the case given that the Technology Sector has risen less than one point per day over the past couple of years, which signifies that there is not a lot of support for these companies from the big end of town.

Unfortunately, there is an expectation from investors that this stellar rise in the US will continue forever, but the steepest rise on a market or stock is just before it starts to fall away. Given the steep rise on the NASDAQ right now, investors would be wise to be very careful when it comes to investing in technology stocks.

Best and worst performing sectors this week

Industrials is up more than 3% followed by Utilities up more than 2%, while Consumer Discretionary and Communications Services are up more than 1%. The worst performing sectors include Information Technology down more than 1% followed by Consumer Staples and Financials, which are both down under 1% so far for the week.

Looking at the ASX top 100 stocks, the best performers so far this week include Evolution Mining, Reliance Worldwide Corporation and Resmed, which are all up nearly 3%. The worst performers include Janus Henderson, Newcrest Mining, National Bank, Suncorp Group and Iluka Resources, which are currently down around 0.20%.

What's next for the Australian share market

This week the All Ordinaries Index fell earlier in the week before rising in the later half, which is the opposite of what the market has been doing over the past few months. This pattern of spending roughly half the time rising and the other half falling means that the Australian market continues to go nowhere. That said, it is trading above 6,369 points and a high close above this level may mean there is still some life in the current bull run.

When the market is in a state of heightened uncertainty, it is very hard to pick when a top or bottom will occur. That said, I still believe the market will pick a direction very soon, which is likely to be down. For now, I recommend you continue to ride the upward move while it lasts and be careful adding stocks to your portfolio in the event the market falls away.

Get stories like this in our newsletters.